Business Structure Options

The Ultimate Inventor’s Handbook page 226 – 227

There are three main factors to consider when chosing a structure for your business: taxes, liability, and organizational structure. The four primary forms of doing business are discussed below. Each form has specific advantages and disadvantages which must be considered when establishing your business. Remember that you can chose one type of business structure now and change it later if it is avantageous for you. As such, you may chose to operate as a Sole Proprietorship now and change to a Subchapter S Corporation at a later date. The tax and liability considerations of the different structures can be quite significant. A visit with your accountant regarding your specific financial situation might be worthwhile before deciding which form of business to use.

Sole Proprietorship

Your business is completely owned by you. You own all the assets and are entitled to all of the profit; you are also responsible for all liabilities and any losses. It is especially easy and inexpensive to start a sole proprietorship and there are no additional income taxes to prepare other than your personal income tax form.

Partnership (Including Limited Partnerships)

Your business is owned and operated by you and at least one other person. Together you share profits and losses, and the assets and liabilities of the company according to a written partnership agreement (recommended, but not required) or an oral understanding. Partners pay income taxes on the individual share of the profits, but no seperate income tax on the business. In most states, your partner can not be your spouse as you are considered one legal entity. Partnerships are also relatively easy and inexpensive to form. The downside to a partnership is that you and your partner have legal liability for one another’s acts.

Limited partnerships are similar to general partnerships except that there are two types of partners; general partners and limited partners. Limited partners are typically investors who, unlike general partners, are limited in legal liability to an amount based on their capital contribution to the business. A limited partnership is limited to 35 owners. Both general and limited partnerships enjoy the benefits of partnership taxation.

Corporation (Including Subchapter S)

A corporation is a separate legal entity formed in conjunction with other owners, or by you alone. A corporation does business in its own name, separate from you and the other owners. A corporation must have articles of incorporation and bylaws. You often need a lawyer to properly establish a corporation. Owners are usually limited in their liability to an amount equivalent to their investment in stock. Corporations must pay corporate income taxes, and the owners must pay individual taxes on any salaries or dividends they receive from the corporation. A corporation is formed by filing Articles of Incorporation with the Secretary of State. Shares of stock are issued to the shareholders, bylaws are adopted, and a board of directors is elected. Corporations cost more to establish but there can be significant advantages.

A subchapter S corporation is formed by making a special IRS election. This election allows the flow-through taxation treatment similar to that of partnerships and LLCs. An S corporation is limited to 75 stockholders.

Limited Liability Company (LLC)

The LLC is a relatively new form of doing business that combines characteristics of a corporation and a partnership. Like a corporation, it is a separate entity and carries liability protection for all of its members, but like a partnership, an LLC does not pay taxes as it has the benefit of flow-through taxation. The owners are called members. The key factor determining whether the LLC qualifies for partnership tax treatment is its similarity to a corporation. In order to qualify as an LLC a company can only have two of the following four traits of a corporation: limited liability, continuity of life, centralized management, and free transferability of interests. An LLC is created by filing a form called, Articles of Organization with the Secretary of State. Most states require that the LLC have some type of an operating agreement.